Many Happy Returns

Ipswitch is a grand master of the elusive art of calculating a site's return on investment

Ask Dennis Mulryan, chief operating officer of Ipswitch Inc., how much his company's Web site cost to develop and launch, and he'll tell you $190,000. He'll call that figure "relatively modest" and point to a list of cost-cutting measures the Web site has allowed his company to undertake. He will also assert that last year the site accounted for some $13 million worth of both direct and indirect sales, more than 60% of the company's total revenues.

Now ask Mulryan to tally his company's total out-of-pocket expenses to run the site last year. This time you'll get a very different number: nearly $1.3 million. In addition, Ipswitch had another $150,000 or so in noncash expenses related to the site, including write-offs and amortization of earlier investments.

At the end of the day, Ipswitch still comes out ahead. And the software vendor, based in Lexington, Mass., is the first-place winner of this year's Inc ROI Web award. But the split between those two numbers illustrates how the cost of building a Web site is just a small portion of the total ongoing expense of keeping a site running. It also illustrates how elusive a true calculation of ROI for Web sites can be.

Two lessons emerge from the Ipswitch story. First, to improve ROI, keep your Web site's costs as low as possible. Second, the real costs of running your site are probably a lot higher than you expect.

Roger Greene, president of Ipswitch, knows well the thorny brambles of calculating Web costs.

The importance of ROI calculations has been driven home by the dot-com implosion. For many dot-coms, ROI never seemed all that important. Extravagant spending on bleeding-edge technology and flashy graphics was the name of the game. When anyone bothered to measure anything, it was with trendy Web metrics such as page views, click-throughs, and number of visitors. Although those numbers can provide a snapshot of a site's traffic, they fail to answer a much more important question: does the site take in more dollars than it spends on its development, launch, and operation?

But even that question alone is too simplistic. To calculate a Web site's ROI, you need to ask questions in these three areas:

Costs: How much money has your company spent to develop and launch its Web site? And now that the site has been launched, how much do you spend on its daily operation, including staffing, systems, maintenance, and improvements?

Revenues: How much in sales and other income can you attribute to your company's site? How much of that is direct -- sales taken in from an E-commerce site -- and how much is from sales leads generated online?

Savings: To what degree does your company's Web site reduce or control expenses, whether by streamlining business processes or by other means? What dollar figure can you put on those savings?

Award winners in Inc's ROI category were able to pinpoint both how their E-business initiatives make money as well as the amounts they're investing in them. "What these firms had in common was that they were thoughtful and careful in documenting the benefits, such as cash flow and profitability," says judge Erik Brynjolfsson, a professor and codirector of the Center for E-Business at MIT.

The award winners also considered the myriad costs involved in running a Web operation. They knew to look beyond the expense of designing a site. In fact, as Ipswitch's numbers show, the ongoing operations can cost far more. "You're fooling yourself if you think that buying a platform is the only explicit cost," says Brynjolfsson.

The winners also were able to account for savings gained by doing business on the Web. According to Martin T. Focazio, an awards judge and author of The e-Factor: Building a 24-7, Customer-Centric, Electronic Business for the Internet Age, an example would be a com- pany that reduces its toll-free phone bill as more customers avail themselves of an online Q&A feature. Even if a Web site brings in no additional sales, Focazio adds, the site can be financially justifiable if it reduces expenses enough to cover at least its own costs.

Determining a Web site's ROI is more an art than a science. Reasonable people can disagree on which costs and benefits should be included in the calculation. Some advocate an extremely inclusive approach. Focazio, for instance, believes companies that sell software over the Web should include the costs of developing that software in their calculations. After all, he says, "programs don't write themselves."

But others, including awards judge Richard W. Oliver, a professor of management at Vanderbilt University, in Nashville, take a more moderate position. They say ROI calculations should include only those costs directly associated with the Web initiative. "I would argue that product costs remain product costs and should not be allocated to the Web," Oliver says. "The Web is just a channel, and you want to look at just the channel costs."

To his credit

Mulryan of Ipswitch practices what Oliver preaches, and he has kept the site's development and operating costs low. When Mulryan directed the development of his company's Web site, he opted for the same low-tech and fairly inexpensive credit-card-processing system that's used by such off-line retailers as gas stations and convenience stores. "We didn't go out and buy a Cadillac," Mulryan says. "We started with something that could get the job done."

That it does. Ipswitch, founded in 1991 and today a 140-employee company, develops and sells software applications for network engineers. Potential customers can head to Ipswitch's Web site to download evaluation copies of the company's products and then test them for as long as 30 days. The evaluation copies turn themselves off after that length of time, so a customer who wishes to buy the software must return to the site to pay and download a permanent copy of the software app.

One of Ipswitch's eight products is particularly well suited to distribution on the Web: WS_FTP Pro, a file-transfer application that sells for about $40 a copy. Offering the software through resellers or a direct-sales staff would be expensive for Ipswitch and inconvenient for its customers. Instead, about two-thirds of all orders for WS_FTP Pro come through the company's Web site.

In fact, of the $13 million that Ipswitch took in last year from its Web site (representing 64% of the company's $20 million-plus in revenues), direct sales accounted for about $7 million. The remaining $6 million in sales were brought in by resellers using leads generated from visitors to the site. Mulryan projects that 2001 sales will reach nearly $23 million and expects that the percentage of sales attributable to the Web will remain about the same as last year's percentage.

Getting started

To achieve that level of online success, Mulryan and his colleagues have made a series of what he calls "cautiously aggressive" investments. In 1996 the company spent roughly $190,000 to design, develop, and launch the Web site. Though that's hardly petty cash, Roger Greene, the company's president, says that even if Ipswitch never saw a return on that investment, the company still would have been able to make payroll.

The $190,000 was spent in two main areas: $40,000 for systems, including computer hardware, third-party software, and development of E-commerce software; and $150,000 for additional software development, including front-end and E-mail marketing systems. That was just the beginning, of course. Now, with Ipswitch's site up and running, its annual operating costs are adding up.

For one, eight employees work on the Web site. Their total salaries, benefits, taxes, and other costs come to about $800,000 a year, or approximately $100,000 a person, says Mulryan.

Of those eight employees, three work directly on the site. Two of them focus on the site's front end, creating material for the support centers and the Knowledge Base section. The third maintains back-end functions, including credit-card processing.

Four employees process customer leads that come through the site, distributing qualified leads to Ipswitch's resellers. Those employees get their information from customers who download Ipswitch software from the site; to get the evaluation copies, customers must first provide information about themselves, including their E-mail address. The final employee maintains the site's discussion lists, where users can ask one another questions and share tips.

Ipswitch finds that distributing software over the Web isn't free, either. Customers whose computers crash, obliterating the Ipswitch software they've downloaded and purchased, usually ask for a replacement copy. The company doesn't charge customers for replacements but instead assumes the replacement costs, which come to about $110,000 annually.

Also, Ipswitch spends nearly $190,000 a year on licensing fees for its online credit-card-processing system. Furthermore, Ipswitch writes off about $105,000 in Web-based sales owing to credit-card charge-offs, which result from orders whose credit-card number has been declared nonexistent by the bank that issued the credit card.

To promote the site, Ipswitch holds trade-show exhibits and buys print advertising. Those promotions cost the company about $150,000 a year.

But wait, there's more. Ipswitch also needs hardware -- servers, PCs, and the like -- to support its Web site. Mulryan says Ipswitch's annual depreciation expense for the hardware needed to run the site is about $20,000. The company also spends about $15,000 annually on its T1 line.

This year Ipswitch redesigned its Web site at a cost of about $50,000. Although that cost was not a factor in the ROI calculations for 2000, Mulryan says that the company reworks the site about every two years to refresh its look and functionality.

More than a penny saved

As part of its online efforts, Ipswitch conducts E-mail-marketing campaigns, which it has found to be both cheaper and more effective than printed mailings. Last year the company sent some 8.5 million E-mail messages to customers who had opted to receive information. Although the sending of E-mail did not completely replace mailings of printed materials in 2000, it did reduce Ipswitch's direct-marketing expenses by about $585,000. The E-mail also achieved a response rate of at least 5% and in some cases as high as 40%; by comparison, Ipswitch's print mailings last year achieved an average response rate of 2%.

Operating the Web site has also allowed Ipswitch to avoid building a huge sales and customer-service staff. Mulryan estimates those avoided costs at about $2.3 million a year. While that doesn't get factored in to a strict ROI equation, by Mulryan's thinking, that's $2.3 million a year the company didn't need to spend. "We've realized that the Internet gives us the opportunity to sell software in the mass market without building a large sales force," he says.

Specifically, Mulryan figures that operating the site lets him limit the number of employees in three main groups: customer service, sales, and tech support. Since customers can now download the company's software on the Web, Ipswitch needs 27 fewer customer-service employees and 5 fewer salespeople than it otherwise would have needed, for an estimated annual savings of $2 million. Also, the Web site has precluded the hiring of 4 technical-support employees, says Mulryan. That's because customers use the Knowledge Base section of the Web site to learn about Ipswitch products or to discuss products with other engineers on the site's discussion boards instead of calling an Ipswitch help desk with questions. Mulryan estimates that those annual savings are roughly $325,000.

Now for the final tally. Ipswitch's total Web costs in 2000: $1.3 million, not including depreciation, write-offs, and other noncash expenses. Total Web-related revenues: $13 million. Total Web-related savings in direct mail: $585,000. Divide the roughly $13.6 million in revenues and savings by $1.3 million in costs to reveal a return of nearly 10.5 times investment. There's nothing "relatively modest" about that.